Is Apple Transitioning From A Hardware First Company To A Software And Services Giant?

There is no denying the fact that Apple Inc. (NASDAQ:AAPL) is a global phenomenon. It is the most valuable company in the world and a darling of the stock market. Apple’s name and brand alone is worth more than what most companies can’t even dream of. The key to Apple’s incredible success over the past decade is no secret. The iPhone is a revolutionary product that kick-started the smartphone revolution back in 2007. Since then, the iPhone has become the gold standard for smartphone software and design, prompting countless imitations. In fact, such is the popularity of the iPhone, that it has almost single-handedly catapulted Apple to the top, and now makes up the majority of their revenue share. However, many have often labelled Apple as a “one trick pony” due to their over-reliance on the iPhone. If Apple Q3 2017 earnings report, ended June 30, 2017, is anything to go by, this may soon be about to change.

Apple Q3 2017: Bounced Back With Strong Sales And Revenue

After a somewhat disappointing second quarter, Apple bounced back in Q3 with better than expected sales and revenue across their product and services lineup. Apple’s quarterly revenue for fiscal Q3 was over $45.4 billion. Quarterly earnings per diluted share came out to about $1.67. This represents a comeback of sorts for Apple, with a 7% YoY increase in revenue over Q3 2016, when the company posted $42.4 billion in revenue. This is an encouraging sign for Apple, who blamed last quarter’s YoY decrease in revenue and sales on anticipation for the iPhone 8.

Apple also registered strong performance across its products and services spectrum. Shipments of iPhone increased 2% compared to Q3 2016, with a 3% YoY increase in revenue. The iPad managed to bounce back, arresting its downward decline with a 15% YoY increase in shipments, although revenue increased by only 2%. The growth of iPad shipments can be attributed to the launch of the new 10.5″ iPad Pro, and strong demand in the US education market, leading to a 32% sales increase YoY here. The story is quite the opposite with the iMac; Shipments grew by a mere 1% YoY, but revenue jumped by 7%.

Is Apple On The Verge Of A Major Transition?

Despite generally improved sales across its major hardware offerings, the highlights of Apple’s Earnings Report were entirely different. Just like fiscal Q2, Apple’s Services business continues to grow rapidly, registering 22% YoY growth to total at $7.26 billion. Revenue even increased by over $200 million compared to fiscal Q2. This is remarkable, as historically Apple’s Q3 revenue is substantially lower than Q2 on most fronts. Apple’s burgeoning service offerings now include AppleCare, ApplePay, App Store, Apple Music and more.

Another division that posted strong revenue numbers was Apple’s fringe products category, which includes the Apple TV, Apple Watch, Beats products and Apple/third-party accessories. Revenue in this category grew by 23% YoY to come in at $2.74 billion.

Looking closely at Apple’s sales and revenue data over the past few years makes one thing clear; Apple’s hardware sales are approaching a ceiling. Many markets are approaching saturation, and there isn’t a lot of potential for further growth. Double-digit growth in iPhone sales is becoming more and rarer, a trend which could become the norm especially considering Apple’s growing troubles in China. In contrast, Apple’s services business has grown unhindered. In fact, analysts predict Apple’s service revenue to grow 17% YoY till 2021, while hardware revenue growth languishes at 2.4%. At this rate, it won’t take long till services take over hardware as Apple’s primary revenue driver.

What Is Driving Apple Services’ Incredible Growth?

There are quite a few factors behind the incredible growth that Apple’s services division is registering:-

The App Store – The App Store is undoubtedly Apple’s most lucrative service business. Sales continue to increase, and analysts estimate a 30% YoY increase until 2021. The App Store has also benefited from Apple’s willingness to accept more and more forms of payment. Alternative methods of payment through third-party systems, or even through the phone bill have helped increase the number of paid accounts. As people start spending on any service or app, total spend increases over time. A prime example of this is the launch of AliPay on the App Store in China, which helped in the growth of paid accounts.

Business Model – One area where Apple’s services are lagging behind is video streaming. However, this is mitigated by the fact that Apple charges a 15% fee for all subscriptions made throughout the App Store. This means that customers who sign up for rival services like Netflix, Hulu etc on the App Store end up benefiting Apple as well.

The Road Ahead For Apple

It is quite evident from Apple’s financial results that the market is shifting. Even Apple’s priorities are gradually transitioning from hardware to software and services. This is clear in Apple’s investment in Augmented Reality and streaming services, including video. Of course, Apple stands to gain a lot from this transition in the long run. The services business operates on higher profit margins and has a much taller growth ceiling. It is also largely unaffected by the seasonal nature of hardware sales, and revenue remains consistent throughout the fiscal year.

For some time now, Apple’s success has been a bit of an anomaly in the context of the general trend. Most of Apple’s major rivals like Google, Microsoft, Amazon, etc. are already heavily invested in the software/service ecosystem, with a much smaller focus on hardware. Now, it would seem like Apple is eventually heading towards a similar road as well.